DELL: Street Mulls the Heavy Price to Stay Afloat in PC Market

By Tiernan Ray

The big takeaway from Dell‘s (DELL) slightly better-than-expected fiscal Q2 report yesterday afternoon was that Dell is continuing to be aggressive on prices, especially in the PC industry, in order to retain business versus top PC sellers Hewlett-Packard (HPQ) and Lenovo (0992HK).

Analysts today were predicting that the company will continue that approach to things both before, and after, it goes private, assuming the LBO proposed by CEO Mike Dell is approved when shareholders put it to vote on September 12th. (Carl Icahnwas busy today trying to derail that deal.)

Dell shares rose 12 cents, or 0.8%, to close at $13.82, just above the $13.75 LBO offer price.

Abhey Lamba of Mizuho Securities USA reiterated a Neutral rating, and a $14 price target, today, writing that “The company’s PC business, especially for mobile devices came in light due to weaker demand for traditional PCs and aggressive pricing.”

We expect the company to become even more price aggressive once it becomes private and eliminates some operating costs. Expense reduction will offer the company more room to cut prices, which would be a negative for other vendors like HP as they will have to respond to Dell’s aggressive pricing. While we expect relatively strong results from HP’s server division also next week, we believe Dell has gained market share over other vendors. However, we note that servers are less than 10% of HP’s revenues and other businesses will continue to experience significant pressure.

Bernstein Research‘s Toni Sacconaghi reiterated a Market Perform rating, and a $15 price target, writing that the company is having to sacrifice margin in the PC business because of an uncompetitive structure:

Dell’s weak gross margin performance is attributable to a continued deliberate effort to sacrifice margins for market share, particular in PCs and x86 servers. We note that Dell has struggled historically in balancing share and profitability, which we think points to a cost structure that remains uncompetitive vs. peers. On a year-over year basis, Dell managed to hold revenues flat in the quarter, but non-GAAP operating profit dollars were down by nearly 50%. Given that the PC market declined by about 10% YoY, and servers by low single digits, it appears as though Dell’s operating profit dollar contribution would have been higher had it simply chosen to cede or hold share, rather than invest to take share. Dell’s ostensible rationale in attempting to gain share is to avoid descaling (which can create a vicious cycle of fixed cost deleveraging and continuous layoffs), invest in acquiring strategic accounts (i.e., ones that have potential to buy significant high margin enterprise offerings in the future) and preserve its high margin support annuity stream. We note that on a fully allocated basis (See Exhibit 1), professional and support services amounted to over 100% of Dell’s operating profit in the quarter.

Richard Kugele of Needham & Co., reiterating a Hold rating on the stock, notes the company paid a price to hold share in the PC market:

Dell noted in its release that according to IDC, the company was the only top 5 vendor to increase PC-unit share both yoy and seq in each of the last two (calendar) quarters. However, we note that the major decline in operating margins suggests just how much price aggression was apparently needed for such an achievement.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.